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21 Jan 2009 15:51
Spiralling state debt is fuelling concern that the eurozone could splinter despite official assurances, including firm remarks from the head of the European Central Bank on Wednesday, that a break-up is all but impossible.
European governments are ramping up their borrowing to pay the huge costs of bailing out their banks and reviving their recession-hit economies, reviving lingering market concerns about eurozone countries with the weakest finances.
The eurozone’s detractors have long argued that the bloc would not be able to hold together if a country in crisis had to resort to unorthodox measures such as “printing money”, especially without having the option of devaluing.
Such concerns have driven the spread or difference between interest rates on debt issued by high-deficit eurozone countries compared to low-risk German government bonds to record levels.
They have also weighed on the euro currency’s exchange rate.
In the face of such developments, top European officials have lined up to deny that the demise of the eurozone is imminent while also insisting on the need for governments to keep deficits and debt under control.
Asked in the European Parliament about fears that the turmoil could force the 16-member eurozone to split, European Central Bank head Jean-Claude Trichet said: “I think these rumours are unfounded about the euro.”
Likewise EU Economic and Monetary Affairs Joaquin Almunia insisted on Monday that market pressures were not an ominous sign that the eurozone would break apart.
“I am not worried at all by those who have announced for 10 years in a row that the euro area will split. Honestly, I don’t think that this is a real hypothesis,” he told reporters in Brussels.
“It is normal that the market assess the risks.
So the existence of a spread in euro area government bonds is logical because not all members of the euro area have the same fiscal position over the medium to long term,” he said.
In an update on Monday of its economic forecasts, the European Commission estimated that the combined public deficit of the eurozone would balloon from 1,7 percent of output to 4,0 percent in 2009 and 4,4 percent in 2010 as governments ramp up spending to get the economy moving again.
However, the overall figure masked a much more dire situation, with Ireland’s deficit, for example, expected to swell to a stunning 13 percent in 2010 and Spain’s hitting 5,7 percent the same year.
EU finance ministers promised at a meeting on Tuesday to tackle their ballooning government deficits once their recession-hit economies pick up but stopped short of fixing binding deadlines.
Czech Finance Minister Miroslav Kalousek, who chaired the meeting, warned that the extent to which governments can run up deficits would not be determined only by them but also by investors’ appetite for their debt.
“It is not just a question of the willingness of these governments but how willing the markets are going to be to keep lending to governments,” he said.
“I think that the market is already registering certain risks to the limits of state borrowing.”
The spread between low-risk German government bonds and debt issued by Greece, Ireland, Portugal and Spain blew out as ratings agency Standard and Poor’s cut Greece and Spain’s rating and warned of a downgrade for the other two countries.
Economist Aurelio Maccario at Italian bank Unicredit argued earlier this week that “the euro is a one-way door” and no country would want to leave as the costs would be too high.
“Clearly, in the long-term a single abandonment or a breakup cannot be excluded but we are rather confident that this is not an option for the short- or the medium term,” he said.
United States economist Barry Eichengreen said that no country would probably ever be allowed to get close to the point of defaulting on its debt and dropping the euro.
“There is an alternative, namely fiscal retrenchment, wage reductions, and assistance from the EU and the International Monetary Fund for the cash-strapped government,” he wrote in a recent paper.
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